November 21, 2007
Who will pick up the thread after the great unwinding?
By Martin Wolf
Is the US going to experience a recession? Two answers must be given to this question: nobody can be sure; and it does not matter. A much more important question is whether the US economy continues to experience a “growth recession”, by which is meant a lengthy period of sub-trend growth. The answer is that it will.
The standard US definition of a recession is two quarters of negative economic growth. This demands both too much and too little: too much because it requires an absolute fall in output, which is an infrequent event in a growing economy; too little, because it is consistent with rising unemployment and declining capacity utilisation. But a lengthy growth recession is likely to be far more disturbing even than a sharp recession, provided the latter ends swiftly.
Most analysts believe that the trend rate of growth of the US economy is around 3 per cent a year. Growth at below that rate, then, is a growth recession. This year, the expectation is for growth of about 2 per cent. Next year, suggests the consensus, it will be a little above 2 per cent. That would mark a cumulative shortfall of about 2 per cent of gross domestic product over two years. So the US is already in a growth recession.
The remainder of this column can be read here. Debate from our guest columnists appears below.
Allan Meltzer: Congratulations to Martin Wolf for getting it right. It is the “great unwinding” of the work that once was hailed as “the Committee to Save the World.” They took the US current account deficit from about $150 billion to $450 or $500 billion to prevent Asia’s recession from spreading. The current account deficit increased from there.
It is at last time to reciprocate. Who is ready to reduce its exports to reduce the US current account deficit? Past experience from the 1960s to the present shows two repeated answers. The United States almost always gave priority to domestic over international concerns. It let the dollar fall rather than tighten policy. The rest of the world disliked a falling dollar, but it also disliked the inflation caused by its efforts to prevent depreciation of the dollar. It had to choose.
The rare attempts to cooperate internationally did not last and did not work. China never puts exchange rate appreciation in a sentence that ends with a date. It allows dollar depreciation to depreciate its real exchange rate. The rest of Asia follows China. The euro has the usual choices - inflation or appreciation.
Talk about a strong dollar neglects the current account deficit. Sure the nominal exchange rate has fallen, but the large current account deficit suggests the dollar IS too strong, not too weak. Given its current domestic problems or expected problems, higher interest rates, reduced government spending, or higher tax rates are not on the agenda.
Posted by: Allan Meltzer | November 21st, 2007 at 5:45 pm | Report this commentMartin Wolf: I agree very much with Allan, of course. It is going to become very messy. The interesting thing to see will be how countries choose between inflation and nominal appreciation in these potentially chaotic circumstances. To me it feels a bit like the early 1970s. Absit omen! I hope things do not end up as they did then, namely, in a global burst of excessive inflation.
Posted by: Martin Wolf | November 21st, 2007 at 9:59 pm | Report this commentAkio Mikuni: I would like to comment whether Japan will be able to pick up the thread and become the demand engines of the world.
Prime Minister Yasuo Fukuda will be remembered as the first Prime Minister to have pledged to administer the government economic policy from the view point of consumers in his first policy speech to the Diet after he was appointed as Prime Minister in October 1, 2007. This will be a sea change, if administered in substance. In recent past, it has become quite clear that, under the national election system of the single seat representation, a majority of the vote could not be won by proposing industrial policies for producers, but could be won by proposing economic policies for a majority of consumers.
Mr. Ichiro Ozawa, the president of the opposition Democratic Party of Japan exploited this situation fully and won the recent election in the upper house in July 2007 by promising voters to improve the living standards of consumers. The LDP, together with the bureaucracy and industrial interests, sought votes of producers, as it had done more or less successfully in the past, but this strategy did not work last time. They failed to support the lifetime employment of workers during the severe adjustment period after the bubble busting, and they have lost both the head counts of full-time workers they employ and loyalty of those workers to vote for the LDP.
The yen has been, more or less, pegged very loosely to the dollars since 1995 when the US started “the strong Dollar policy”. Japan’s MOF intervened in the foreign exchange market to support the dollars until early 2004. Since then, Japanese banks, in MOF’s place, have bought external assets, a large part of which could be denominated in the dollars. Furthermore, BOJ’s easy money policy helped and encouraged capital outflow out of Japan through the entire period. However, recent price appreciation in many consumer goods and products, occasioned by rising commodity prices such as oil, is threatening the living standards of consumers seriously. Prime Minister Fukuda acknowledged during the interview given by Financial Times on November 12, 2007, that the long term trend of a rising yen should not be rejected. This is remarkable in a sense that LDP, seeking for the weak yen for the benefit of Japanese industries, appears to have changed one of the most important economic policy pillars of the LDP.
I am not convinced of the change yet. It is yet too early to say Prime Minister Fukuda would stick to his statement and would act accordingly. Also, he has not gone far enough to promote the strong yen policy affirmatively. He would not be politically strong enough to go against the strong will of “profitable” exporting industries which favors the weak yen policy. Meanwhile, in the light of rising commodity prices, it is debated in a few places and openly that the strong yen policy should be beneficial for consumers as well as small-medium firms in service industries, which rely on imports and employ a majority of workers. Under the politically alert leadership of Mr. Ozawa, DPJ might seek the strong yen policy, provided that ordinary Japanese might come to see how closely their economy should be linked to the exchange value of the yen. The up coming election of the lower house could become plebiscitary in nature as the currency policy could generate binary divide in Japan between LDP backed up by producers and DPJ backed up by consumers. Then we will find out an answer to Martin’s question.
Posted by: Akio Mikuni | November 22nd, 2007 at 2:27 am | Report this commentI thank Akio Mikuni for his interesting comments on Japanese politics and the possibility of a “strong yen” policy. My guess is that as long as Japan hovers on the edge of deflation, there will be little acceptance of such a policy.
My view is that Japan’s fundamental problem is structural underconsumption in the private sector. This is not because households are not spending a high enough proportion their disposable incomes, but because too much of national income now ends up as undistributed corporate profits (i.e. corporate savings).
These undistributed profits are far more than the Japanese corporate sector can profitably invest at home. So these excess savings have had to be offset either by public sector dissavings or by the current account surplus.
The solution, therefore, is a reduction in these undistributed profits. There are two ways of achieving this: higher taxation of profits, ideally to finance lower taxation of households (which would probably be better than higher public spending); or higher distribution of profits to shareholders. The latter could be achieved by strengthening ownership rights and encouraging a market in corporate control or by taxing retained earnings more and distribution of corporate income less.
Either way undistributed corporate profits (now largely unnecessary, given the already huge corporate capital stock) would be turned into household income. On the current evidence, such income is now quite likely to be spent. Then the macroeconomic structure of Japan would at last start looking more like that of most other high-income countries.
I intend to write a column on this topic in the New Year.
Posted by: Martin Wolf | November 22nd, 2007 at 9:28 pm | Report this comment